by P.E. KelleyMr. Kelley is managing editor of Advisor Magazine, and Advisor e-newsLink, it’s daily magazine. Connect with him by e-mail: firstname.lastname@example.org.
The longevity risk is not a wholly new idea. Today’s income industry has certainly identified it and begun to construct financial strategies that are responsive to its principal need, namely, making nest-eggs last… often twice as long as they once needed to.
But the idea has now begun to perceptibly infiltrate the thoughts of consumers, your clients, who are slowly becoming aware that they just might have to alter a once idyllic vision of retirement. There’s a problem in paradise.
Rebekah Barsch is vice-president of planning and sales with Northwestern Mutual. Her job description includes the responsibility for ‘execution of the company’s comprehensive financial planning approach’… And that she does.
Using her company’s 2016 Planning and Progress Study as a launch point, she discussed subtle though significant changes in consumer behaviors about saving, about what retirement means to them, then and now, and how advisors can better understand emerging attitudes that are reshaping the very concept of Our Golden Years.
PEK: We recognize the Longevity Risk as a principle that informs so much of the retirement income process. How do you define it within the context of this study?
RB: What I think is most interesting about it is that this is really the first generation that is going to need to figure out how to financially manage longevity.
In the past, of course, longevity was managed for you, either by the government or by your employer or both. Now, for many of the clients that we do business with, Social Security represents an increasingly smaller portion of their retirement income. As such, there is noticeably less confidence about the future for the next generation of Social Security.
And people are trying to figure this out. As if saving for retirement isn’t a big enough challenge, now you have to structure retirement income in an effective way to manage an ever-increasing longevity.
PEK: How well are consumers dealing with the uncertainty of longevity?
RB: I kind of see this as a double hit to the American public and a challenge for advisors as well: getting clients to first accept it and then try to figure out how to put a safety net under themselves to make their money last. At the same time, however, they must acknowledge a sobering realization that their longevity will not necessarily look like their father’s. I wish I had a dollar for every time a client says, “Well, my dad dropped dead of a heart attack at 74.”
PEK: So people still tend to view it through their parents eyes?
RB: Yes, they tend to project what ever happened to their parents or even their grandparents on to their own longevity, instead of really understanding the implications of an emerging ‘improvement curve’ that we’re seeing in mortality. Of course, their parents had the benefit of a longevity safety net. But for this generation, I don’t think that most clients fully understand the challenge of making retirement income last, even to normal life expectancy.
However, normal life expectancy has changed dramatically. For an adult entering retirement at age 65, someone in a married couple has roughly a 60% chance of living past the age of 87. So, what this means to a lot of people is that they’re going to take their money, try to project some return on it and carve it out to an annual income that leaves them coming to a shrieking halt at age 87. But I have to say, I find this hilarious because if one of them lives past 87, they’re going to be looking at each other saying, “Now what do we do?”
So yes, life expectancy doesn’t mean that you’re both going to drop dead in that projected year and so retirement income is not a finite, simple mathematics equation. This is only the beginning of the struggle.
PEK: How prepared are Americans for what will probably be a longer retirement span?
RB: Half of them are saying that they have not proactively addressed the financial implications of living longer. They may be aware of the phenomenon, but are simply not addressing it. And this assumes that they were in good financial shape for a normal longevity, but of course many are not.
PEK: Did any evidence emerge from the report that would suggest that people want to save but can’t afford to? Is there a more basic economic reality in play?
RE: I think the word can’t is kind of a strong one. So, if most of the people that we talked to had a solid financial plan in place, and then said “I can’t afford to save for retirement,” that would be more compelling to me. But very few Americans even have a financial plan. What we’ve learned is that there are new pressures that create excuses for not saving more.
The two big ones are health care costs and debt.
Health care, obviously, has been on its own inflation-rate trajectory for years now and that’s taking a bigger and bigger chunk out of people’s retirement savings and income, both before and after. But debt is becoming a larger and larger concern. I’m sending my son off to college in the fall and I can’t believe it’s going to cost us a quarter of a million dollars to go to a private school for four years. That is unbelievable when I think what I went to college on.
PEK: Where does debt typically manifest for the average consumer?
RB: The simple answer is we have an increasingly material society. There is a sense of, “I’d like to have a second vacation home and whatever else,” or “I want to have a vacation right now,” and this pushes the priority to save farther down the pike. The root cause is consumerism. There are just so many places to spend money. People are very attracted to all of those shiny objects out there; cars, homes, trips, everything. It’s much more fun to do that than to defer that gratification for a period of life that can seem a long way off.
But there is a second trend that has to do with attitudes towards debt. For many, there is something quite freeing about being out from underneath a mortgage in retirement, but for those of us that locked in a mortgage at historically low rates, it may not be the brightest thing to do at all. It might just make more sense to keep investing money for retirement income instead of paying the house off at retirement. Leveraging home equity with a low-interest mortgage can be so advantageous, particularly when that includes favorable tax advantage. But this is an attitudinal hurtle.
It is an entirely different scenario with high interest rate credit card debt, however, which burdens so many.
PEK: That can be a hard thing for an advisor to suggest: keep the mortgage.
RB: The real challenge is to figure out how to help people structure retirement income in a way that gives them a position to help their assets continue to grow, while also giving them that base level of guaranteed lifetime income, no matter what happens. For each individual situation, of course, that is a unique combination and strategy. I see more of today’s advisors embracing this idea. They are getting their clients to ask “what it’s going to take to solve this increasing longevity problem?”
PEK: How do you answer the client who asks, simply, “How much money do I need to retire?”
RB: It’s so funny that you ask that, because we talk about this a lot. And we take the opposite approach. The first question we ask is “what is the lifestyle you wish to live, and what are the financial resources needed to support it.”
We have clients all over the country, some of them living in very affordable markets, some of them living in California and everything in between. So, we urge them to establish what we call a reverse budget. We encourage them to take a look at what they are spending today, while they’re still earning an income, and then they work with their advisors to draft a budget of what retirement will look like.
Of course, the interesting thing is that some expenses totally go away. Their parking expenses at their workplace, some of their commuting costs, even their wardrobe, dry-cleaning… all these kind of things may go away. But then there are other expenses, depending on what they’re looking for in retirement that may significantly increase, like travel, doing special things for their kids. What this does, in effect, is provides a way for them to back their way into shaping what a good retirement might look like for them. Then, we take a look at what they’ve saved and we determine whether there is a gap, and if so, how much there is.
So, what about those clients with no other outside help except Social Security and a half-million dollars saved? We have to ask them if they think they are they going to be in good shape retiring at age 65? I would say, probably not. I’m just hard pressed to see how a half a million dollars and a slice of Social Security is going to get a 65 year old who’s in good health comfortably through to the end.
PEK: On a percentage basis how unprepared are Americans to retire? How many people out there are in for a big surprise?
RB: That’s a good question. People tend to be optimistic, but there’s this gap between optimism and what they’ve chosen to do and I think the big challenge is, and the role of the advisor is, to help people move forward and execute, because people procrastinate, and their behavior gets in the way. They all have good intentions, but so often it’s just not on their radar at all.
The most effective strategy is helping them envision the retirement they want. As soon as we can do that, and then put a price tag on it, it suddenly becomes more tangible for our clients and they say, “Oh, if this is how I want to live, when I stop earning an income or stop earning a full-time income, then here is what I need to do to get there.” Prior to this kind of realization, it feels more like something important that they need to do, but it’s not yet in a helpful context.
I think about our kids coming out of college and we strongly encourage them to start saving today. They’ve got the power of compound interest and time-valued money and all that, so we’re encouraging them, tuck away their money now, take advantage of qualified plans at work and any match that your employer might offer. It seems like a long way away, even though it’s a good exercise to do. Where it really becomes real and where people are willing to dig deep is when they have a feeling for how much that retirement is going to cost them. The only real way to do that is thinking about an annual budget as opposed to one big number.
PEK: So, have the ‘Golden Years’ become a bit tarnished?
RB: It’s funny. People used to say “I need to do better than my parents did and not only that, but I want my kids to do better than I did.” Today, this is being replaced by “I just want to be happy, spend time with my family, and feel a sense of peace of mind around my finances when my head hits the pillow at night.”
I actually think that’s a positive development, because it’s showing at the end of the day, not that I’ve got a bigger house than my dad and mom had, but that what’s going on inside that house and my relationships with my kids and my husband are in good shape.
This steps away a bit from that consumerism, which never stops. There’s always a bigger goal, the better vacation, the bigger cruise ship and it’s just endless. I think that the preponderance of media, 24/7 streaming, the Kardashians, oh my God, you just can’t turn anywhere without seeing the next private island. Everywhere you turn, there is the next thing to acquire and at some point you just have to halt and say it’s no longer really worth pursuing. What’s really important at the end of the day, for more and more people, is having a more balanced life.
PEK: How do people perceive Social Security today?
RB: In the survey, about a quarter of Americans think it’s extremely likely that Social Security will be around when they retire. Will some kind of safety net be around? I think there will be. But the very next question is, what will it look like? Will it be structured or phased out by income? Will it be a smaller percentage of what it takes to actually support yourself in retirement? I think all those things are on the table.
PEK: Like will we work until we’re 80?
RB: Yeah…exactly! The age at which we can claim will certainly rise and I think the longer we live in this prolonged low interest rate environment, the more strain we have on that whole system. But the idea that Americans would have zero safety net, I don’t think we’re seeing that just yet.
PEK: How are people affording healthcare in retirement? Just how big a wild-card is it today?
RB: I like the way you phrase that: a wild card. It seems like every question you ask me has two moving parts to it. So, first, there’s the economic model for health care: we’ve got Obamacare, we have private health care, and we have employer subsidize care. There are a lot of pieces to that puzzle for people in different situations entering retirement, not to mention the whole Medicare system.
But then, if we layer on top of that this increasing longevity puzzle, which can certainly drive up health care costs, then it’s hard to nail down a reasonable percentage of retirement income to be spent on healthcare. Which makes it really difficult when trying to install our strategy of reverse budgeting.
So, what we generally do is go to the medicare.gov site and take a look at what the local cost of Part B premiums are for clients and help them to navigate that. But there are a lot of out-of-pocket costs and the longer somebody lives, the more health care costs they might incur.
So yes, wild card is a good word for it. I know there is a lot of work under way to try to stabilize the spiraling cost of health care. For now, maybe that trajectory has narrowed a little bit, but it’s still climbing up. ◊